A Turnabout on Corporate Taxes
Economists who favored rate cuts under Obama suddenly deny they’d result in higher wages.
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Suddenly, an idea that has been accepted by economists and by policy makers on both sides of the political aisle—that high taxes on business hurt investment, workers and the economy—is considered “absurd.”
In 2012, President Obama and his advisers proposed lowering the corporate tax rate because it “creates good jobs with good wages for the middle-class folks who work at those businesses.” In 2013, Lawrence Summers, President Clinton’s Treasury secretary and chairman of Mr. Obama’s Economic Council, argued that the tax on corporate profits creates a burden without commensurate revenues for the government, and that changing it “is as close to a free lunch as tax reformers will ever get.”
In 2015, Democrat Chuck Schumer and Republican Rob Portman co-sponsored a Senate bill to reduce the top corporate tax rate, which is the highest of any of the 35 countries in the Organization for Economic Cooperation and Development. “Our international tax system,” Mr. Schumer argued back then, “creates incentives to send jobs and stash profits overseas, rather than creating jobs and economic growth here in the United States.” Bill Clinton in 2016 said he regretted raising the corporate rate to its current level.
Yet President Trump’s Council of Economic Advisers (of which one of us is a member) is now being accused of partisanship and unscientific analysis. When the council released areport using standard and widely accepted methods of the economics profession to find that cutting the corporate tax rate from 35% to 20% would raise the wage income of an American household by an average of $4,000 within a 10-year time-frame.
The critics include Mr. Summers and Jason Furman, who served as chairman of the CEA under Mr. Obama—both of whom backed cutting the corporate tax rate during Mr. Obama’s presidency. Their main methods of criticism include qualitative introspection—the world works this way because I think so—without reference to a supporting scientific base. Other arguments use economywide times-series correlations—taxes are not as bad because both taxes and America grew in the 1990s—omitting other variables driving them, such as the explosion of the internet. Neither method is accepted by the economics profession.
One of the few substantive quantitative points they raise is that they believe the government will receive $200 billion less in corporate tax revenue if the corporate rate drops from 35% to 20%. They write: “We see from the CEA estimates that they predict American households will receive two to three times this amount in the form of higher incomes! That’s impossible!” That’s a fundamental misunderstanding of the CEA paper—and, more important, of how the economy works. Not only is it possible, it happens every single time.
This argument also contradicts several decades of standard tax analysis. To illustrate, consider a $1 million tax on airline tickets. People wouldn’t fly, so no government revenue would be collected—and thus the harm of the tax would be infinitely as large as the revenue. Likewise, a tax cut in which the expansion of the base exactly offset the reduction in the rate would have no revenue effect, so society’s gain from the cut would be infinitely larger than the revenue loss.
In the standard economic framework, including Mr. Summers’s own work, the long-run loss in revenue to the government is always less than the addition to workers’ wages, because resources are freed up to engage in more productive activities.
The gains to factors from a tax cut is always more than 100% of the loss in Treasury revenues, but how much larger? Standard economic models of capital investment predict it’s 200% to 300% of revenue losses—as a $4,000 wage increase implies. That is supported by many different strands of the literature and why economists Edward Lazear (a CEA chairman under George W. Bush ) and Laurence Kotlikoff, a father of many organizations’ tax models, among others, find worker wage effects similar to those found by CEA. Nevertheless, according to Mr. Summers, anyone using these standard models—which includes Mr. Summers in his own work—is “dishonest, incompetent, and absurd.”
Messrs. Summers and Furman now belatedly acknowledge that standard economic analysis vividly contradicts their initial proclamations. So they have tried to backtrack by saying that basic economics omits “complex issues” and so must now be irrelevant. But these so-called complex issues are not new. Nor are they complex. Nor do they change our analysis and conclusions. Economists Robert Hall and Dale Jorgensen first analyzed these issues in 1967, and improvements of that literature have been used by CEA in both past and recent analysis.
Among these issues, the economists profession is fully aware that the corporate tax favors—among other things—investments that are debt financed, have quicker depreciation, or can be assigned to foreign jurisdictions. All these distortions by the corporate tax code suggest larger, not smaller, output expansions per dollar of revenue by the proposed tax reform.
The Obama economists go on to favor the current corporate tax rate because, although most corporations are not monopolies, the corporate tax is absorbed by those that are. Widely accepted facts contradict that argument. In particular, economists have mountains of evidence that monopolies are a problem as they withhold production to raise prices. This means that too little capital and labor get used in their industries compared with the rest of the economy, and that too little is used in the economy overall. Thus, keeping the corporate tax only exacerbates this labor underutilization.
CEA of course welcomes debate on the merits, or the existing science, of the case. But these types of argument are neither.
Mr. Mulligan is a professor at the University of Chicago and author of “The Redistribution Recession: How Labor Market Distortions Contracted the Economy” (Oxford, 2012). Mr. Philipson is a professor at the University of Chicago and a member of the President’s Council of Economic Advisers.
Appeared in the October 25, 2017, print edition.